Credit update: NIP and tuck

Liquidity is king

In a world dominated by the relentless progression of COVID-19, companies have had their fair share of challenges. From March onwards, it became apparent that having a significant liquidity buffer was going to be a key element in avoiding a downgrade to high yield or worse, a default, and companies have rushed en masse to issue fresh debt into credit markets.

This surge in issuance was also motivated by yields hitting new lows, which were driven down by central bank intervention all over the world. The actions taken by central banks and governments to try and stem the pandemic-led global economic collapse resulted in record issuance levels in investment grade credit markets in the first half of 2020.

Over the year to date, European and sterling credit issuance has amounted to over 500bn euro equivalent, representing more than 65% of 2019 total issuance. In comparison, US issuance has surpassed $1.1 trillion this year, which is more than 90% of last year’s total issuance.[1]

In combination with credit spread levels, which were higher than they have been for many years, we believe this has created exciting opportunities for investors.

NIP and Tuck

The new issue premium (NIP) is a premium over the existing bonds for a given company that acts as an incentive for investors to buy the same company’s new debt. In normal market conditions, this premium is usually positive but small. However, in April and May, NIPs rose substantially as credit investors’ appetite to purchase new bonds was feeble, requiring handsome compensation to absorb the new bond supply in a highly volatile market environment.

So what now?

Spreads in European and sterling investment grade markets have retraced around 70% from their widest points in March as markets returned to a more ‘normal’ state and NIP levels reduced significantly. This makes credit selection even more important when aiming to pick the winners and avoid the losers.

When the tide is out…

The market volatility in the first quarter of 2020 presented us with large NIPs, abnormal credit curves, and credit spreads going from one extreme to another in a matter of weeks. However, we cannot rely on NIPs indefinitely, as each stage of the economic recovery will have its own challenges and opportunities. Avoiding ‘losers’ will be as important as ever, particularly ahead of anticipated volatility in the future, and should prove critical if liquidity once again returns to the spotlight and NIPs resume their rise.

[1] Third-party data: JPMorgan